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Previewing Italy's Election

Italy held another successful debt auction Monday, selling €4 billion in two-year bonds at 1.434% (down from 1.884% in December), with demand at 1.45x coverage. This follows an €8.5 billion sale of one-year bonds at 0.864% (1.456% in December) on January 10 and a €6 billion sale of new 15-year bonds through a January 15 syndicated placement, which drew €11 billion in offers—with 60% from foreign investors. With foreign demand returning and 10-year yields near two-year lows, Italy seems decently positioned to meet its 2013 financing needs.

Of course, yields could very well fluctuate—and they might do so as next month's election draws near. The February 24 contest pits the center-left Democratic Party (PD), led by Pier Luigi Bersani, against current Prime Minister Mario Monti's centrist coalition and former Prime Minister Silvio Berlusconi's center-right coalition. The outcome will determine whether Italy remains on the reform path Monti charted during his year-plus term.

Bersani, the current front-runner, is pro-euro and says he respects Italy's commitments to EU debt and deficit targets. He also largely supports Monti's reforms, though he's suggested some need tweaking—like the labor reforms, which he's said he'd amend to make it cheaper for companies to hire workers on long-term contracts, and the property tax, which he'd narrow down to the most expensive properties. He also pledged to reduce state involvement in the economy and crackdown on corruption and tax evasion—largely what you'd expect from someone who ushered in several free-market reforms as a cabinet minister during the last two decades.

Recent polls put Bersani's support between 34% and 38%, which could position PD to win a majority in the lower house and form a coalition with Monti's group in the Senate—a partnership both men seem open to. However, those surveys came before the PD became ensnared in the scandal surrounding Italy's oldest bank, Monte dei Paschi di Siena, potentially jeopardizing Bersani's support. After requesting a €3.9 billion state loan to meet European capital requirements, bank management admitted to hiding trading losses of over €700 million, calling government oversight into question. PD controls the Sienese government, and PD members run a foundation owning a 38% stake in the bank (its largest shareholder).

Berlusconi seized on the connection Saturday: "The PD can't even run a bank, so how can we trust them to run the country?" Deputies in his People of Freedom (PdL) party sang a similar tune. As yet, Berlusconi hasn't declared his candidacy, and he's coy when asked if he'll run. Should he become the PdL's candidate though, it's far from certain the former prime minister can use the bank scandal to regain office. For one, Berlusconi's not exactly squeaky clean—he was sentenced last October to four years in prison for tax fraud (he's currently free on appeal), and investigations into some alleged sordid behavior are ongoing. Plus, any momentum gained on Saturday likely evaporated Sunday, when he defended Mussolini with gushing praise at—in a terrible turn of irony—a Holocaust remembrance ceremony. Global outrage rightly ensued, as did calls for Berlusconi to be prosecuted under Italian laws banning the defense of Fascism. (His half-hearted retraction hours later did nothing to quell the blowback.)

Yet, while it might be tempting to write Silvio off as a joke candidate (assuming he stands), he does poll at around 25%—enough, perhaps, to threaten the likelihood of a Bersani/Monti coalition in the Senate. Then again, most of his support comes from PdL strongholds like Sicily—PdL may win Senate seats in these regions, but it seems highly unlikely voters turn out in droves to support Berlusconi on a national level. Even if PdL does prevent Bersani and Monti from winning a combined Senate majority, Bersani need only control the lower house to form a government. At the moment, that appears the most likely outcome.

Thus, while anything could happen, Italy's post-election policy direction likely maintains the status quo. PdL may make some noise in the Senate, but likely not enough to overcome a strong pro-euro majority in the lower house. At worst, PdL could make future reforms difficult—not an ideal situation given Italy's remaining competitiveness issues, but far better than upending last year's progress. And as long as Italy's government remains committed to finding a more sustainable fiscal path, markets should continue providing some breathing room.

source: Market MinderDisclaimer: This article reflects personal viewpoints of the author and is not a description of advisory services by Fisher Investments or performance of its clients.
Such viewpoints may change at any time without notice. Nothin herein constitutes investment advice or a recommendation to buy or sell any security ot that any
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